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May 17, 2013

Any Luster Left for Precious Metals?

Understanding the world's different metals and their dynamics in the global economy is key to maximizing their value in portfolios, say experts at ETF Securities

It’s been a bumpy stretch for precious metals.

The price charts for gold, palladium, platinum and silver all showed prices dropping below their 50- and 200-day moving averages in recent weeks. Gold and silver both peaked early last autumn; palladium and platinum topped out in the first quarter of 2013.

Is it time to write off the metals and their role in portfolio diversification?

Nick Brooks, head of research and investment strategy for ETF Securities in London, would disagree with that conclusion for several reasons. Precious metals’ price changes are driven by different factors, he notes, so it doesn’t make sense to lump them together.

Gold tends to draw the most attention as an inflation hedge and its role in jewelry. Silver tends to be highly correlated with gold but it’s also an industrial metal, while palladium and platinum are purely industrial metals.

Another factor to consider: An investor’s time horizon will influence his or view of a metal’s investment potential. Brooks notes that the near-term fundamentals, perhaps other than technical- and short-covering rallies, are not particularly positive for gold.

Nonetheless, he believes the long-term underlying fundamentals are very bullish.

“I think investors rightly fear currency debasement, printing of money and, therefore, look to gold as a hedge against the debasement of the world’s major reserve currency, the dollar in particular,” he says. “But, even if those fundamentals are still intact that doesn’t mean that cyclical factors won’t affect prices and you can’t get shorter term down trends in an upward cycle.”

The recent decline in gold’s price has drawn considerable attention. ETS Securities cites several reasons for it in an April report: “In our view it was a classic case of speculative investors taking advantage of gold-negative fundamental news and technical break-points to drive a self-fulfilling downward cascade of the gold price. Given the size of short COMEX futures positions, an equally powerful short-covering rally may also occur once markets have stabilized, new technical levels evolve and gold fundamental news improves.”

In contrast, Brooks is bullish on palladium and platinum for both short- and long-term investors. His cites two main reasons. First, these metals are in short supply. Brooks says both experienced a supply deficit last year and are expected to remain in deficit this year.

The second reason is that the eventual resumption of stronger economic growth in the U.S. and China will increase demand for the metals. “There are very strong fundamentals for those two metals, and I think ultimately, assuming the U.S. growth and Chinese growth recovery continues, they should ultimately be strong performers.”

That economic recovery could also benefit silver, Brooks believes. “Silver is a hybrid,” he says. “I would argue that it does have a relatively high correlation with gold over time. It has been used historically as currency and is viewed as a store value. But, around 50% of silver is used for industrial purposes, particularly in the electronics industry; and, therefore, it also should benefit if growth continues to recover. And, often in this type of environment, it quite substantially outperforms gold.”

Additional reasons to consider keeping metals in a portfolio are provided by Nitesh Shah abd Nicholar Brooks of ETF Securities’ research department. In late April, they highlighted why they believe the commodity super-cycle that started in the late 1990s is far from over:

Substantially higher absolute levels of demand and the increasing scarcity and rising cost of commodity production will force prices higher over the next 10 to 20 years.

Industrialization, urbanization and rising wealth of large populations in the emerging markets will continue to drive demand higher.

Although there’s a likely reduction in the economic growth rates of China and India over the next 20 years, per capita incomes still are expected to triple there over the coming 20 years.

The long-term supply of most commodities will remain constrained due to increasing scarcity and rising costs of production.

Higher prices will encourage more efficient use of the world’s scarce resources and should incentivize investment and innovation necessary to boost supply productivity